#187 | The NAIC IUL Multiplier Vote

James and I recorded a podcast on 10/18, the day after the NAIC vote, but have yet to release it because James has been unexpectedly out of the office for personal reasons. As a result, I’m writing this Quick Take to cover the topic before the podcast is released.

Ten days ago, the IUL Illustrations Subgroup of the A Committee at the NAIC took a “directional vote” on whether or not products with index credit multipliers should illustrate better than products without them. I was on the call for the full 90 minutes, eighty-five of which were dedicated to various arguments and angles for why ICM products should illustrate better than traditional IUL products and to what degree. When Fred Andersen (MN) asked for a vote at the end of the call between eliminating illustrated benefits of multipliers (so-called #2) and providing for illustrated benefits for multipliers subject to “severe restrictions,” it seemed like fait accompli that #3 would win. But then chair Mike Boerner (TX) led with an “informal” vote for #2, which kicked off a cascade of votes in favor of #2 for a final tally of 14-6. I was so shocked that I could barely speak. What in the world just happened? And what in the world happens next?

But first, let’s clear on what did not happen. The NAIC did not just kill index credit multipliers – this is about illustrations, not the product feature itself. The NAIC took a directional vote, whatever that means, not a final and binding vote. The NAIC has not yet proposed specific language updates to AG49 as a result of the vote.  They have not put forth a definition of a multiplier or specified what kinds of multipliers may be restricted and what kinds won’t, if they decide to make distinctions. They have not stated whether or not a restriction on multipliers would also apply to other policy features, such as high cap accounts or fixed interest bonuses. The NAIC, in other words, didn’t do anything with this vote. As comically predictable as PacLife’s response to the vote was, they were correct when they pointed out that “discussions are still underway.” The vote was simply a way for the NAIC to declare their intended outcome, somewhat like declaring war. When, where, how, under what terms and by whom the war will be “won” is yet to be determined.

Furthermore, it’s unclear whether or not AG49 is a war or a battle. AG49 operates within the confines of the Illustration Model Regulation, created to curtail the illustration abuses of its day, and it’s becoming increasingly apparent that broader questions about life insurance illustrations need to be revisited as well. That’s a huge undertaking that might not ever happen but, if it does, the results could likely upend everything about life insurance illustrations – including AG49 and Indexed UL illustrations.

For my take, I’ve had two reactions to the NAIC vote over the past week. The first, besides shock, was elation. Eliminating illustrated multiplier benefits would put a chill on the most aggressive and egregious sales strategies and illustrations that I see almost weekly. But almost immediately, that feeling was replaced by something else, something deeply unsettling – the feeling of being caught between principle and result, like seeing something work out the way you think it should but for all the wrong reasons. I feel, in other words, incredibly conflicted. I support the outcome of the vote, to restrict illustrated multiplier interest, but not the premise of the vote itself, which was that multipliers should be singled out. Allow me to explain.

What is the difference between an index credit multiplier and a normal indexed credit? Trick question – there isn’t one. They are exactly the same thing. They are paid at the same time. They are paid under the same conditions. They are linked to the same non-guaranteed elements. The only difference occurs in the final calculation, when the size of the final credit is predicated on the size of the multiplier. Differentiating between an index credit multiplier and a normal indexed credit would be like saying that beer from a draught is fundamentally different than beer in a bottle. The vote at the NAIC essentially seeks to curtail multipliers without changing the way the base product illustrations – in other words, to curtail draughts (multipliers) without addressing bottles (traditional indexed credits). What would lead a regulator to do something like that?

From the outside, it looks like the regulators got a little bit spooked about a long-standing bar patron who figured out that the bartender would happily fill a gallon jug straight out of the draught, which led to these patrons becoming more than a little tipsy and roughing up the other folks at the bar. The problem with draughts, of course, is that the theoretical limit to the size of the glass they can fill is the keg itself. And if any one person imbibed an entire keg in one sitting, well, that would be a real problem. So we can’t have any of that.

As a result, the regulators figured that it would be better to just eliminate draughts altogether without putting restrictions on bottles. This seems like a good idea, until you start to think about the fact that bottles come in all sizes and can be filled with different beers. A few patrons have already started to order some pretty huge bottles and are getting just as tipsy as the guys at the draught, which means they’re roughing up the folks at their tables too. And furthermore, some of the patrons are figuring out that the alcohol content of a Coors Light (4.0%) isn’t even close to a Victory Sour Monkey (9.5%, no joke). What looks like a little bottle can bring a flush to even a seasoned patron’s face if the bottle is full of Sour Monkey. These patrons are getting pretty tipsy too and have started to trade punches with the big-bottle and draught crowd.

The problem, as this analogy hopefully shows, is not whether or not the patrons drink from draughts or bottles. The problem is that the patrons get tipsy and trade punches. In fact, that’s what they live to do. It’s quite literally their job. And the fact that this bar happens to be the only one serving beer in a bone-dry county means that eventually, everyone shows up for drink and fights, hoping to get a few bloody knuckles to show their bosses back home.

In the case of Indexed UL, the beer is option profits. Where else in the land of fixed insurance products can an insurer assume and illustrate annual asset returns of 45% without taking any risk? Nowhere but Indexed UL. That’s why it’s the only bar in the dry county. The bottles, of course, are traditional index credits and the draughts are the index credit multipliers. The gallon jugs being filled straight from the draught are charge-funded multipliers. The beer bottles come in different sizes because almost every carrier, to varying degrees, is artificially propping up their current cap in order to juice their maximum AG49 illustrated rate. The different types of beer are different crediting strategies and proprietary indices that can illustrate different levels of theoretical option profits. Each of these strategies, in other words, has a different ABV potency. Filling a bottle with a Coors Light isn’t the same thing as filling a bottle with Sour Monkey in the same way that a cap on the S&P 500 doesn’t illustrate the same option profits as a 150% participation rate on a proprietary index specifically designed to maximize hypothetical lookback performance. And, finally, I’ll leave you to figure out which patrons are which.

So will the NAIC’s directional vote of limiting draughts while retaining bottles stop drunk bar patrons from giving each other bloody noses? Absolutely not. That’s what they do. And in order to keep doing it, they’re just going to become much more adept at selecting and filling their bottles. This is the problem with the vote. This is why it is so deeply unsettling to me. The NAIC has offered zero rationale for why it chose to single out multipliers for additional regulation in the same way that the NAIC offered zero rationale for why it allowed extreme option profits in the first place. This is regulation by feel. 6% illustrated rates in Indexed UL don’t feel too aggressive, despite the fact that the only way you get from a fixed rate product to a 6% illustrated rate is to have option profits north of 35% these days. But extending that 35% option profit assumption to charge-funded multipliers, which can result in 10%+ cash value IRRs, feels too aggressive even though it uses the exact same core assumptions as 6% illustrated rate. Regulation by feel leads to confusion, subjectivity and inconsistency. Regulation by principle leads to clarity, objectivity and consistency. It’s high time to take a principles-based approach to illustrating IUL.

Rather than taking an up/down vote on illustrating multiplier interest, the NAIC should instead tackle the tough and rigorous task of publicly and empirically evaluating option profits. It will be hard work. It will cause rifts and divisions in certain states between insurers and their regulators. It may lead to some very uncomfortable, but internally consistent, conclusions. If the answer is that option profits are real and reliable, then multipliers should be fair game regardless of how tipsy the patrons become. If the answer is that option profits are uncertain (as in, non-structural) or heavily path-dependent, then the tap needs to be shut down.

Similarly, regulators should take a hard look at whether or not it makes sense to allow theoretical profits from a specific investment strategy to directly pass through to illustrated performance in a non-registered product that can be sold by insurance-only licensed agents. If so, then that opens the door to a bevy of new breeds of fixed insurance products with direct or indirect ties to specific assets beyond just equity call options as in Indexed UL. It’s another tough question that must be tackled as a part of the IUL debate and that will result in some very uncomfortable discussions.

In the end, moving forward to craft regulation based on this recent vote on index credit multipliers in isolation will leave the core issues unsettled. The bar will still be serving beer and the patrons will still be getting tipsy and roughing each other up. Maybe that’s unavoidable, but I don’t think it is. It’s time to deal with the hard issues – the questions of whether or not option profits are empirically reliable and whether or not they should be illustrated in a fixed insurance product – not take a vote to single out multipliers for special restrictions.